What’s the difference between a budget and a financial forecast? 

While these terms tend to be used interchangeably, and both deal with financial planning—their purposes are very different. 

Let’s explore the differences between budgets and forecasts, and why one might be worth doing more than the other.

What is a budget?

A budget is a financial planning tool to estimate spending and income generated by your business over a certain period of time (typically once a year).  

In practice, budgeting is primarily focused on expense allocation. Where a set amount of resources are allocated for the next quarter or fiscal year and are regularly reviewed against actual results to determine accuracy and make corrections if necessary. 

Creating an expense budget is a useful first step for consistent financial planning and reporting d. Setting income expectations and spending limits provide useful guidelines for your business to remain healthy. 

Budgets can also be created for sales and detail specific sales targets for specific products. 

They are granular, detailed, and usually built to help salespeople stay on track. However, business budgeting can be limited due to its static nature and focus on spending limits.

What is a financial forecast?

A financial forecast is a projection (or educated guess) of what you expect to happen to your business. It’s a high-level prediction of business performance based on a combination of historical data, market research, and growth objectives. 

Forecasts encourage you to consider the big picture to help your business grow. They are driven by broader goals, like how much revenue you can bring in from an entire business segment or how market conditions may impact performance.

Creating a financial forecast provides a high-level, strategic view of where you want your business to go short-term (the next few months) and long-term (1-5 years). 

Complete financial forecasts include all three financial statements: 

• •Profit and loss statement
• •Cash flow statement
• •Balance sheet

The key to a successful forecast is to avoid getting hung up on granular details. Unlike a budget, you don’t need to account for every single item you sell, or each expense you have. 

Instead, focus on broader sales and expense categories. 

For example, if your business brings in X amount in revenues per year and wants to double that within a year—how will you get from here to there? Will your cash reserves sustain this level of growth? 

Or, if an economic downturn occurs, what changes will you have to make to survive? What expenses can be cut? How long will your cash last if sales dry up?

A financial forecast is your tool for understanding these financial scenarios. 

Key differences between budgeting vs forecasting

In its simplest form, a budget is used for managing expenses while a financial forecast is a strategic revenue roadmap based on your business goals. 

But the differences are even more nuanced than that. 

1. Level of detail

Budgets tend to be more detailed and precise, breaking down revenues, costs, and resources into categories to set firm spending limits. These are intended to be followed exactly to help maintain control over your business finances and ensure that resources are allocated efficiently.

Forecasts are often less detailed and provide broader estimates of your revenue, expenses, and cash flow. This makes forecasts far more flexible than budgets and therefore easier to review and update as you go.

2. Time frame

A budget typically covers a fixed period, usually one fiscal year, and remains relatively static once it’s set.

A financial forecast can cover anywhere from the next one to five years with varying levels of detail. It’s intended to be updated regularly (monthly, quarterly) and provides a rolling outlook based on new information, market changes, and internal performance.

Keep in mind, that the further out you go, the less accurate your forecasts will become. So, these forecasts should be even less detailed and more focused on broad business performance. 

3. Purpose

Budgets are used to allocate resources, manage spending, and assess performance against set targets. During a quarterly or annual review, businesses will often compare current spending against their budget to determine how well they’re performing.

Forecasts are used to guide decision-making by predicting future financial conditions. Forecasts can inform decisions related to production, inventory, and resource allocation, as well as help identify potential opportunities and risks in the market. By reviewing against actual performance businesses can proactively adjust their business strategy by identifying opportunities or risks early on.

Why financial forecasts are better than budgets

Financial forecasting and budgeting are somewhat two sides of the same coin. However, there are a few key reasons why forecasting is the better practice for small business owners to adopt. 

1. Provides a full financial picture of your business

First, financial forecasting paints an entire financial picture of a business by addressing all three financial statements: profit and loss, cash flow, and balance sheet,  sometimes called a three-way forecast.  Budgets are typically more focused on setting expense limits, and are best made after a forecast scenario is built. 

To build the full picture, the forecast is based on all the elements of the underlying business model.  Besides revenue and expenses, things like capital expenditures and debt servicing, and even elements like strategic partners and other resources are considered. 

2. Makes you more proactive and aware

Second, financial forecasting covers a longer period of time.  

A full forecast typically looks out over 12 – 24 months, or even longer depending on the size and maturity of the business. Budgeting is usually limited to the current fiscal year.  

Within this longer view, your forecast provides far more detail at a month-to-month level. 

Specific, shorter periods of the forecast can be analyzed and updated based on real-world occurrences. Combined with this fuller picture (often called a “look” at the business) you can more easily understand the impact of internal decisions or external events have on your long-term performance. 

Your budget is really only useful for looking back and seeing if you’re staying within your spending limits.

3. Easier to review and update

Finally, forecasts are updated and reviewed monthly, as time progresses and more is known.  To be an effective management tool it must be up to date.  

A forecast is designed to be updated monthly.

The update is a key part of the process, because each period’s actual results bring insights to business performance, and reset the forecasted cash and profit figures.  This allows for a better understanding of your business’s future and more confident and strategic decision-making.  

Budgeting on the other hand is typically done once each year.  Budgets are sometimes updated mid-year, but as they are typically more focused on expense limits, the practice of updating them is not as common. 

Should you do a budget or a forecast?

While budgeting and forecasting go hand in hand, small businesses shouldn’t get mired in the process and the terminology. Instead, if you’re running a small business, you should focus first on creating a forecast. Once you determine your sales goals and broad categories for expenses, you can dive in and add additional detail where it’s necessary. 

At the end of the day, you want to focus on systems and tools that help your business grow. Create financial projections that meet your business needs, and then use them on a regular basis to measure your performance and adjust course as necessary.

To get started download our free sales forecast and cash flow forecast templates or consider using financial forecasting software like LivePlan. 

LivePlan guided forecast builder and automatic financial statements remove the need to mess with any financial modeling or make manual updates. That way you can spend less time creating a budget and forecasts and more time running your business.